Third Party Litigation Funding: \

April 6, 2011

This article was written for and first featured in Liability Risk & Insurance

The third party litigation funding industry is still very much in its infancy. Its development in the UK will be significantly influenced by the measures likely to flow from Lord Justice Jackson's Review of Civil Justice Costs and by the changes to the legal profession introduced by the Legal Services Act. City of London law firm, Fox Williams LLP, in conjunction with legal research company, Jures, has commissioned a study, entitled "The New, New Thing", of the market in third-party litigation funding. The study is the culmination of interviews with leading players in the third party funding market, including insurers, third party funders, leading litigators, academics and commentators.

Most insurance companies will be familiar with the concept of funding litigation since the advent of after-the-event insurance in the mid-1990s and the establishment by Allianz of a third party funding venture (in 1997 in Europe and 2007 in the UK). Third party funding differs from after-the-event insurance in a number of respects. In essence, third party funding is a means by which a third party provides funds to a claimant to finance litigation costs. The third party funder must have no other connection with the litigation: it may not control or direct the litigation. The funding can cover the costs of the litigation, either in whole or in part, or cover disbursements only. The extent of the funding will be a matter of agreement by the parties and the majority of agreements for third party funding are highly bespoke. In return for providing funding, the third party funder will, if the claim is successful, expect a financial profit on its investment. This is usually calculated either as a percentage of the damages (or settlement figure), or a multiplier of the investment provided by the funder, but again will be the subject of negotiation between the parties.

Cases which are likely to be funded are those which have been given a high prospect of success (usually by a leading barrister) and where the amount of the claim is significant (cases worth less than £500,000 are unlikely to be funded and most third party funders require claims to be worth at least £2 million). This is because the third party funder’s only interest in the litigation is that it makes a profit from its investment. If the quantum of the claim is less than, say, £500,000, the third party funder is unlikely to be able to make a sufficient return from its investment. Third party funders will also want to ensure that the defendant is good for the money, and will commonly only fund cases where the defendant is a large publicly listed company, a governmental body, an insurance company or an insured party. Accordingly, it is the large commercial cases which are of most interest to third party funders.

The study, however, identifies that third party funding is still relatively unknown and, therefore, under-exploited. At present, it is estimated that only about 100 commercial cases have been funded using third party litigation funding. The individuals interviewed for the study gave mixed predictions as to whether third party funding is likely to become more mainstream in the future.

If more cases are funded in this way, the implications for the insurance industry are four-fold.

Third party funding will enable claimants who would not otherwise be able to afford to bring claims, to do so. As insured parties are seen as ‘ideal’ defendants because there is unlikely to be any difficulty enforcing judgments against them, insurers may expect to see a rise in claims. This also applies to policy coverage disputes where the insurance company is itself the defendant.

Insurers who bring subrogated claims may be able to use third party funding to hedge their risks and take liability off their balance sheets in respect of the costs of the claims. In the study, Susan Dunn, of Harbour Litigation Funding explains the rationale behind claimants who can otherwise afford litigation taking out third party funding: "in other cases, [claimants are] saying: 'I can afford to pay for everything, but I don’t litigate every day of the week and I'd rather co-fund because I like the certainty of knowing how much I am going to spend'".

More insurance companies may follow Allianz's lead and launch funding ventures themselves.

Third party funding and after-the-event (ATE) insurance are closely related: third party funders will often want to remove the risk of having to pay the defendant’s costs by ensuring that ATE insurance is put in place. Developments in third party funding may necessitate changes in ATE insurance products, particularly in light of Lord Justice Jackson’s Review which recommends abolishing the recoverability of ATE premiums.

The study identifies a number of factors which will determine the success of third party funding in the UK and also draws on the experience of third party funding in the United States, Australia and South Africa.Investors’ appetite for riskAccording to the Civil Justice Council, no more than about 100 cases have been funded by way of third party funding. The former chief executive of the Civil Justice Council speculated that: "there is a lot of money behind [third party funding] but more than the funders appear prepared to risk". Reasons cited by various commentators for such cautiousness range from the recent economic downturn to potential restrictions on third party activity advocated by Lord Justice Jackson. Yet the true position is not so clear. Amongst the interviewees for the study, there was disagreement.

According to Susan Dunn: "just because you haven’t heard about it, doesn’t mean that it's not going on. A lot of cases that we fund have been confidential. There have been lots of well-known cases that have actually been funded but people just don't know it".

However, Rocco Pirozzolo, senior underwriter at QBE, suggested that: "funders are asking investors to tie up their money for the best part of five years before there is any return. There can’t be many investors who are willing to shut away millions of pounds for no return for a long stretch of time. It's a big ask in this economic climate".

The impact of Lord Justice Jackson’s Review of Civil Justice Costs

Lord Justice Jackson was charged by the Master of the Rolls to conduct a review of the costs of civil litigation and to provide recommendations in order to promote access to justice at a proportionate cost. The Jackson Review was published in January 2010.

The conclusions of the Jackson Review broadly support third party funding for the following reasons: for some parties, third party funding is the only means to fund litigation and, therefore, promotes access to justice; it is better for a claimant to recover a substantial part of a damages claim than nothing at all; it does not impose an additional financial burden on opposing parties; if the recoverability of conditional fee agreement success fees is abolished, third party funding becomes even more important as a means of financing litigation; and third party funding tends to filter out unmeritorious cases.

However, Jackson's endorsement of third party funding was not wholehearted and he made a number of recommendations. He recommended that third party litigation funders establish a voluntary code of conduct. This suggestion has been acted on by the main players in the industry, who announced in March 2010 an industry body to oversee a voluntary code of conduct: the provisions of the code are currently being consulted upon.

Jackson suggested that a third party funder should only be entitled to withdraw funding if there are proper grounds for doing so, and he highlighted the need for third party funders to demonstrate capital adequacy. For insurers who are defending claims, these two recommendations ought to be welcomed. The consequence of the sudden withdrawal of funding or a lack of capital adequacy is that an insurer who has been put to the cost of defending a claim may not be able recover its costs from an unsuccessful claimant.

Jackson also recommended that third party funders should be exposed to liability for all adverse costs. This is on the basis that it is wrong in principle for a litigation funder who stands to recover a substantial share of the damages awarded in the event of success to escape part of the liability for costs in the event of defeat. Currently a third party funder's liability for adverse costs is capped at the level of the amount it has funded. As already mentioned, third party funders can avoid the risk of having to pay adverse costs by ensuring that ATE insurance is put in place. However, if the recoverability of ATE premiums is abolished (as recommended by Jackson), this may lead to the demise of the ATE market.

The Jackson Review also supported lawyers being able to act on a contingent fee basis. This means that instead of traditional hourly fee arrangements, lawyers can take a cut of the damages, as is common in the United States. This method of litigation funding is a rival to third party funding, as the lawyer is financing the costs instead of a third party funder. Again, the commentators interviewed for the study had mixed opinions as to whether this would inhibit third party funding. Views ranged from Richard Fields of US investment fund, Juridica, arguing that: "[the] big problem in the UK market from an investor's point of view is the absence of a risk culture in the legal profession", to Wayne Attrill of Australian funder, IMF, who concluded that: “even if contingency fees were brought in for the UK, I do not think that that would be the end of the litigation funding industry".

The study concludes with what appear to be the critical issues for the development of third party funding in the UK.

The success of third party funding will depend on the degree to which it is embraced by the legal profession and their clients, and the main threat to the industry is lack of awareness.

Investors need to be convinced that third party litigation funding is an attractive alternative investment.

Whether a system of voluntary self-regulation can deal with the concerns identified in the Jackson Review of capital adequacy, the circumstances in which a funder can withdraw funding, and liability for adverse costs; and

Whether the current model of third party litigation funding (which in practice is only appropriate for large commercial claims) can be adapted to finance lower value and consumer type claims.

A copy of the report "The New, New Thing" is available by emailing marketing@foxwilliams.com